1 Chapter 2 – Measuring Financial Health Important parts Construct & interpret financial statements Budgeting Record-keeping Financial planners

2 Measuring Financial Health Balance sheet – as of a particular date –Assets – what you own –Liabilities – what you owe/borrowed –Net Worth – a measure of your wealth Assets less liabilities is net worth

3 Types of Assets Monetary assets – cash Investments – provide income Retirement plans Automobiles Real estate Personal Property Other – owed to you

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5 Liabilities Money you owe –Unpaid bills, credit cards, car loans, mortgages Only include principal on balance sheet Liabilities may be current or long-term Net worth equals assets less liabilities Insolvent – owe more than assets worth

6 Income Statement Shows where money comes from and goes –Covers a period of time; uses actual cash flows –Helps you stay solvent Variable or discretionary versus fixed or mandatory Paper trail is hard to follow

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8 Ratios – Financial Thermometers #1. Do I have adequate liquidity to meet financial emergencies? –A. Current ratio is liquid assets divided by current liabilities –B. Months of living expenses covered by liquid assets

9 #2 – Ability to Meet Debt A. Debt ratio asks –What percent of assets financed by borrowing? –Do I have too much debt? Debt ratio = Total Debt Total assets

10 Savings #3 - Am I really saving as much as I think I am? What percentage of after-tax in come is being saved? Measured by savings ratio Not saving = living above your means Pay yourself first!

11 Record Keeping Organizing and maintaining records is essential for financial planning –For taxes, tracking expenses, preparing family for an emergency Systems – from software to envelope system Good checklist on page 46

12 What is a Budget? “A method of going broke methodically”

13 Cash Budgets Plan for controlling cash inflows and outflows to keep expenditures in line with income Done on both monthly and cumulative basis Show and explain variances by line item

14 The Budget Process Purpose: know where money comes from and where it goes. –Take remedial action to control spending –Both forward and backward looking Starts with income Expenses divided into mandatory and discretionary spending What’s left should be change in savings

15 Budgeting Steps Start with latest income statement Estimate tax liabilities and other deductions Identify fixed (mandatory) expenses Identify variable (discretionary) expense –Any way to reduce? Calculate amount available for savings. –Is it sufficient to reach goals?

16 Financial Planners Wide range of services: Help develop plans and budgets; sanity check Various types – usually registered w/ SEC/state But often insurance or securities sales people Understand their compensation arrangements Do commissions affect recommendations/ judgment?

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